Auditing Multinational Enterprises 5. Introduction to Transfer Pricing

Transfer Pricing Refers to the pricing and other conditions in place between related parties Transfer pricing is most often an issue in cross-border transactions within a multinational enterprise group … but is also sometimes applied to purely domestic transactions Applies to a very wide range of transactions – goods, services, intangibles, financial, rental payments … in every type of industry

The Effect of Transfer Pricing What happens to each company’s profits if the sale price: Increases? Decreases? Cutting Edge Corporation Sale of products Cutting Edge (B)

Importance of Transfer Pricing Transfer pricing affects the amount of revenue and profit recognised in members of multinational groups MNEs may use their transfer pricing for tax planning – recognising taxable profit in low tax (or tax sheltered) jurisdictions Other motives than tax planning: customs duties, price and exchange controls and dividend policy Transfer pricing is seen as one of the most important issues facing MNEs

Article 9 (1) “If conditions made or imposed between associated enterprises in their commercial or financial relations differ from those which would have been made between independent enterprises, then profits that, but for those conditions, would have accrued to one of the enterprises may be included in the profits of that enterprise and taxed”.

The arm’s length principle Article 9(1) states the arm’s length principle. Taxable profit is to be computed on the basis that transactions between related parties take place on the same terms as those between unrelated parties. The principle of comparability is central.

Comparability Distinction between: Controlled transactions, that take place between related parties, and Uncontrolled transactions, that take place between unrelated parties. Arm’s length terms are: derived from uncontrolled transactions .. and applied to controlled transactions.

Comparability Factors A comparability analysis focuses on five factors: Nature of product Contractual terms Functional analysis (including assets used and risks assumed) Economic conditions Business strategy